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Asking the right and wrong questions

It’s comforting to believe that the world is simple and can easily be guided by simple heuristics and models. Our reality, however, is vastly more complex.

Dan Airely argues that we need to spend more time helping people understand and deal with complexity and less time concocting dumbing-down mechanisms.

A perfect example of what happens when you dumb down complexity occurs in the personal finance industry. When we face something as complex as money, we have an urge to simplify the problem. But we often oversimplify it, by creating add-water-and-stir solutions.

Typically, a financial adviser takes 1% of assets under management—annually!—to balance a portfolio, and makes investment decisions on the basis of our answers to two questions: (1) “How much of your current salary will you need in retirement?” (2) “What is your risk tolerance on, say, a 10-point scale?”

Frankly, I think highly trained monkeys could do the same basic job given answers to those two questions. Certainly algorithms can do it, probably with many fewer errors. This is just not something for which we should pay 1% of assets under management. But the real reason we should not pay for it is that those questions don’t help optimize our portfolios.